WEAKNESSES

Uncertainty over resolution of Agrokor case, the country’s largest company and employer

Weak industrial development/lack of competitiveness

Manufacturing exports (22% of GDP) of medium or low added value

Poor absorption of European funds/administrative complexity/corruption

Low female employment rate and high youth unemployment

Emigration taking away skilled workforce

RISK ASSESSMENT

Buoyant activity

The economy is expected to post a third boom year in 2018, buoyed by domestic and foreign demand. Even if the effect of the tax cuts in 2017 are expected to fade, household consumption will benefit from firm employment and wage trends, the recovery of credit and tourism benefits. Public investment, especially in energy and transport, will benefit from improved absorption of European funds, while private investment will rise somewhat due to high corporate debt levels (80% of GDP), despite the resumption in credit and growing tourism requirements. Tourism (25% of GDP) will continue to benefit from the disaffection with several Mediterranean countries, while exports of goods (timber, underwear, shoes, electric transformers, engines, automotive parts, boats, medicines, electricity) will benefit from the conquest of strongly performing European markets. Moreover, to maintain competitiveness in the tourism sector, the central bank is expected to intervene on the markets to maintain the stability of the kuna and keep monetary policy in line with that of the ECB. However, trade’s contribution to growth could be negative, as imports will be boosted by internal demand. Resolving the failure of Agrokor is not expected to have a significant impact, unless it unfolds in a disorganised and unsystematic way, in which case local suppliers and their employees could be affected.

Fiscal consolidation to be continued

The country exited the European excessive debt procedure. The public accounts are close to equilibrium and, if one excludes debt interest, are even showing a surplus (primary balance). Apart from better control of current spending, the improvement greatly relies on the beneficial impact of the return to growth on tax receipts. This relativises the improvement and introduces a cyclical fragility. The wage bill remains high and the national collective wage agreement means it is expected to rise in 2018. Likewise, social transfers, not sufficiently targeted to those who need them most, military pensions, spending on defence and healthcare will also rise. On the income side, the banks’ cancellation of non-performing loans, let alone the final cost of a messy management of the collapse of Agrokor, will put pressure on income from corporation tax. Against this, the authorities are expected to benefit from greater absorption of European funds and higher social security contributions, as well as from lower borrowing costs. However, the primary surplus and growth are enough to bring about a slow easing of the heavy burden of debt, three quarters of which is denominated in euros and mostly held by domestic institutional investors, of which the banks, 90% of which are subsidiaries of Austrian and Italian groups. Progress is made difficult by the size of the informal economy (28%) and the many state-owned enterprises, often low-profit or unprofitable businesses, which employ 13% of the workforce.

Tourism and European funds are essential

The current account balance has shown a surplus since 2013. This covers a large deficit (17% of GDP 2017) in the trade of goods offset by tourism income (20%). Nevertheless, the current account surplus is expected to decline in 2018. Strong export and tourism performance will be outweighed by rebounding imports associated with the problems local industry has in responding to demand and with the high import content of exports. Meanwhile, the sum of remittances from expatriate workers and European funds will be close to that of outgoing dividends and interest payments. Foreign direct investments, 4% of GDP in 2016, from the European Union, previously concentrated in the banking sector, will be directed to real estate, energy and chemicals in response to the development needs of tourism and for energy resources. External debt accounted for 78% of GDP at end July 2017. Primarily denominated in euro, it represents exchange rate risk for non-financial companies (40% of the total), the public sector (30%), as well as for the banks (8%, markedly declining). However, the risk is lessened by the kuna’s peg to the euro, a counterweight to the economy’s strong euroisation (almost 60%).

Strong opposition to reforms

Less than a year after voters went to the polls, early elections in September 2016 returned the coalition formed by the centre-right Democratic Union (HDZ) and the reformist party MOST (The Bridge). This coalition swiftly fell apart over the reform programme. The Prime Minister and leader of the HDZ, Andrej Plenkovic, has managed to form a new coalition with the liberals from the People’s Party (HNS). With 78 seats (of which 61 for the HDZ) out of 151, it is weak. The programme of reforms aims to restructure the administration and public-sector enterprises (1/3 of jobs), if necessary through privatisation and job cuts, to review social security benefits and the pension system and to reform the hospital system. It is sparking opposition, not only from the social democrats in the SDP, but also within the HDZ. There is consensus over the refusal to accept the judgement of the Permanent Court of Arbitration granting Slovenia access to the sea through the Bay of Piran, the construction of the Peljesac bridge linking the northern and the southern coasts of Croatia by spanning Bosnia’s only and narrow maritime access, as well as the management of the Agrokor case.